The Euro-Dollar Rate Week Ahead: Charts Argue for Consolidation as U.S.-Iran Tensions Set to Weigh

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- EUR softens in New Year trade amid rising risk aversion. 

- Charts suggest EUR downside is limited, recovery ahead.

- But U.S.-Iran tensions set to dominate FX in week ahead.

- German factory orders and industrial production data due. 

- U.S. nonfarm payrolls, ISM survey also in focus for USD. 

The Euro ceded ground to the Dollar in the opening days of the New Year and rising tensions between the U.S. and Iran mean the it could face further downward pressure early in the new week, although technical analysts say the downside is limited and that fresh gains are likely before long.  

Europe's single currency has been on the back foot from moment one in the New Year following strong gains earlier in the week, although the downward correction was egged on Friday by an increase in risk-aversion across markets amid a spike in tensions between the U.S. and Iran, which favoured the Dollar and Yen in the world of FX.

Risk currencies had rallied into the New Year as investors celebrate President Donald Trump's claim that his 'phase one deal' with China will signed on January 15, with which enabled the Euro to challenge the top of a six-month range heading into year-end.

However, investors will wake Monday to reports of more hawkish U.S. rhetoric toward Iran that could again prove supportive of the Dollar and a headwind for the Pound. Commerzbank says the Euro-to-Dollar rate could now be due a period of consolidation but tips it to break out to the upside from its six-month range later this month.

"EUR/USD charted an outside day to the downside yesterday and looks set to consolidate recent gains. The market sits at a critical juncture – namely the 55 week ma at 1.1202 and the 2019-2020 down channel at 1.1221," says Karen Jones, head of technical analysis at Commerzbank. 

 Above: Euro-to-Dollar rate shown at 4-hour intervals. 

"Dips lower will ideally hold over the 1.1066 20th December low but this is reinforced by the 1.1040 3 month support line and while above here our outlook stays positive," Jones says. 

Jones says the Euro will likely spend the next three weeks attempting to sustain a move above 1.1221, which coincides with the upper boundary of a downward sloping trend channel that dictated trading through much of last year. She says that once this level is overcome, the 200 week moving average at 1.1360 will then be achieveable and has told clients to buy the Euro around 1.1168.

The Euro-to-Dollar rate has been treading a relatively narrow three-cent range since the end of June, spanning the distance between 1.09 and 1.12, with gyrations driven by the ebb and flow of headlines relating to the U.S.-China trade war and Eurozone economy. However, the exchange rate spent the dying days of 2019 attempting to break out of that range to the upside. 

"If USD/CNY doesn’t break lower, then EUR/USD will likely not break materially higher as consensus otherwise expects it to. We are overall yet not sharing the EURphoria of consensus forecasts but struggle to see a large downside in EUR/USD as well," says Andreas Steno Larsen, a strategist at Nordea Markets.

Above: Euro-to-Dollar rate shown at daily intervals. 

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The Euro: What to Watch

Europe’s single currency advanced on the Dollar and Pound during the European session Friday but still close the week a fraction lower against both, although the outlook for the week ahead is uncertain.

The Euro was borrowed and sold frequently last year in order to fund wagers on emerging market currencies, which have all cratered ever since the killing of Iran’s General General Qassem Soleimani, so it could benefit intermittently from weakness in the developing world if investors have to buy back the single currency in order to exit their exotic trades. And those emerging market currencies, not to mention other risk assets, might not fare too well on Monday when markets wake to the latest threats from the U.S. against Iran.

"The Japanese yen should once again outperform - especially against those risk-sensitive currencies directly exposed to oil exports via the Straits of Hormuz, i.e. the Korean won and the Indian rupee. Notably EUR/USD has shown very little correlation with world equities over recent months and, on balance, we would favour higher USD yields and US near energy independence keeping EUR/USD gently offered," says Chris Turner, head of strategy at ING.

Fresh geopolitical tensions have prompted fears of a conflict with Iran in the Gulf and thrown the Dollar a lifeline because previously it was being crushed by jubilation over Trump’s claim that the much-vaunted but always-elusive ‘phase one deal’ to end the trade war with China will be signed at the White House on January 15. That had fueled an increase in so-called risk currencies as well as the Euro, although economic data due out of Europe will also have an impact on the Euro-to-Dollar rate in the week ahead.

Key items on the economic docket include Eurozone inflation figures for December as well as German factory orders and industrial production numbers for November. With Europe’s most recent and ongoing bout of economic weakness having its roots in the industrial sector of the continent’s largest economy, Wednesday and Thursday’s figures will be watched closely by the market for signs of a turnaround. Especially after China’s manufacturing PMI indices were shown stabilising for the month of December, suggesting the worst of the global industrial sector’s woes may now be behind it.

Markets are looking for Eurozone inflation to rise from 1% to 1.3% for the month of December and for the core rate of inflation, which excludes food and energy items from the goods basket, to hold steady at 1.3%.

The numbers are unlikely to cause any harm to the Euro although the European Central Bank (ECB) is seen as unlikely to lift its interest rate any time soon whatever the economic and inflationary weather so the data might not do much positive for the single currency either. German factory orders are expected to have risen 0.3% in November after declining -0.4% in October while industrial production is seen rising 0.9%, which would partially reverse a 1.7% decline from the previous month. The numbers will need to beat market expectations in order to have any hope of engineering and upturn in the Euro-to-Dollar rate.

“The greenback remains a well-functioning safe haven for global investors when geopolitical risks are involved. When the bombs fall, investors push into the dollar,” says Ulrich Leuchtmann, head of FX strategy at Commerzbank. “It is therefore not surprising that, in light of the news of US air strikes on Iran, the Dollar Index (DXY) is rising and marching towards 97.00 again, and that EUR-USD is relinquishing most of its gains from the end of 2019.”

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The Dollar: What to Watch

The Dollar received a drubbing in the dying days of 2019 as investors celebrated U.S. claims that a 'phase one deal' with China will be signed mid-month although it was saved from further losses early in the New Year by a sharp rise in tensions with Iran, which look set to offer further support to the greenback in the days ahead. 

President Donald Trump said on New Year's Eve that he will be signing his phase one deal with China in the White House of January 15 before visiting Beijing shortly after to begin phase two of the negotiations, which will be more ambitious than the last. The deal will see some of the tariffs imposed on exports either side in the last year reduced and will prevent further hostilities so long as its terms are adhered to and talks continue between the two sides.

The announcement is a win for the troubled global economy and so encoraged an immediate bid from investors for so-called risk assets although the positive moods is being increasingly undermined by tensions between the U.S. and Iran, which have risen since the White House claimed responsibility for a missile attack on an Iran-backed militant group in Iraq that led to protests outside of the embassy in Baghdad and culminated in the U.S. killing of Iran's General Qassem Soleimani on Thursday. 

"Both US Treasuries and the dollar have started the year on the front foot as the escalation of tensions between the US and Iran has prompted renewed safe-haven demand. While we think that Treasury yields are unlikely to move much in 2020, we expect the dollar to continue to recover from its autumn slump," says Jonas Goltermann at Capital Economics. 

President Trump may now have upped the stakes again when saying via his Twitter feed late Saturday the U.S. has preselected 52 sites inside Iran for attack in the event that any of its bases or personnel in Iraq or elsewhere are targeted by the Gulf state's forces. Investors are unlikely to welcome the hawkish White House rhetoric, which could see risk assets remain on the back foot Monday and safe-havens continue to outperform.

Capital Economics says a war between the U.S. and Iran would shave 0.5% off global GDP due to a likely collapse of Iran's economy and the impact of higher oil prices on inflation and real GDP growth. That prospect could keep stock markets under pressure and the Dollar supported on Monday although economic data will also be a key focus of the Dollar in the week ahead too. 

“The greenback remains a well-functioning safe haven for global investors when geopolitical risks are involved. When the bombs fall, investors push into the dollar,” says Ulrich Leuchtmann, head of FX strategy at Commerzbank. “It is therefore not surprising that, in light of the news of US air strikes on Iran, the Dollar Index (DXY) is rising and marching towards 97.00 again, and that EUR-USD is relinquishing most of its gains from the end of 2019.”

The Dollar's gains moderated late Friday when the Institute for Supply Management (ISM) manufacturing PMI fell to its lowest level since the financial crisis for December, even though markets were looking for a modest gain in the index. So the greenback could suffer again on Tuesday of the ISM's sister survey of the much larger services sector also follows suit at 15:00 Tuesday. Consensus is looking for the latter to rise from 53.9 to 54.5 for December. 

December's nonfarm payrolls report will also garner a lot of attention at 13:30 Friday, although more so if it manages to disappoint economist expectations. Consensus is looking for the economy to have created just 150k new jobs last month after producing a 266k increase in November, while the unemployment rate is seen holding steady at a multi-decade low of 3.5% and average hourly earnings growth is seen rising from 0.2% to 0.3%. 

"All roads lead to non-farm payrolls Friday," says Andrew Grantham at CIBC Capital Markets. "After such a huge gain in the prior month, it makes sense to expect a deceleration in December. Provided the slowdown isn’t too severe (i.e. payrolls growth is still above 100K) market reaction shouldn’t be that big."

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